monetary_policy_and_asia

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Monetary policy and its impact on exchange rates during the Asian Financial Crises (11/12/01):

Monetary policy and its impact on exchange rates during the Asian Financial Crises (11/12/01) With reference to: “Thailand, Malaysia, Indonesia, Phillippines, Korea” Yunus Mermerci Matt Palumbo Dragos Cazacu

THE MONETARY POLICY:

THE MONETARY POLICY The term “MONETARY POLICY” refers to the one country’s central bank role to determine: the amount of money the cost of credit : interest rate Economic Indicators provide a snapshot of the economy’s health

MP has strong influence on::

MP has strong influence on: Performance of the country’s economy Inflation (measured as CPI) Currency exchange rate Balance of Payments (BOP )

The Goals of MP:

The Goals of MP Promotion of Sustainable economic growth Full employment Stable prices Sustainable pattern of international payments The Tools of MP Open market operation : buying and selling securities Discount rate : interest rate charged on short term loans Reserve requirements : required portion of deposits of a bank

How MP can combat inflation?:

How MP can combat inflation? Causes of inflation: Excess growth of money and credit relative to the supply of goods and services in the economy Combat Measures: making sure that money and credit don’t grow too rapidly or too slow Example: in 2001 US FED cut 10 times short term interest rate to combat inflation. Efficient?

How does the MP creates money?:

How does the MP creates money? Open Market Operations buying and selling previously issued or new issued government securities central banks injects money in the economy Money creation affects interest rates and further exchange rates. Example: June 1997 Asian crisis, sharp rise i n Thai interest rate determined the drop of bath

Interest Rates & Exchange Rates:

Interest Rates & Exchange Rates Growth and interest rates How are they affected by one another What is the correlation between them

MP Impact On Exchange Rate During Asian Financial Crisis:

MP Impact On Exchange Rate During Asian Financial Crisis MP Response to Asian Financial Crisis - As pegs were abondoned--- Rapid depreciations in Thailand, Malaysia, Indonesia, Korea, Philippines. - Higher Inflation, Banking Sector Distress, Recession (BS effects stimulating problems) IMF Stance: “Tight Monetary Policy” - Stabilize ExRate, Restore Confidence, Recovery - Counter-productive? Investor confidence? Reduce loan repayment ability? Banking System?

Arguments for Tight MP in Crisis:

Arguments for Tight MP in Crisis In aftermath of ‘floating’, tightening constrain depreciation. Convince Private Sector that MP is under control, prevent inflationary expectations and cycle of inflation & Exchange Rate depreciations. Raise attractiveness of domestic currency assets. Reduce Demand; cool economy, limit imports. Encourage restructuring external debts

Criticism of Tight MP in Crisis:

Criticism of Tight MP in Crisis Initial I Rate hikes fails to stabilize currencies Required I Rates too high to sustain? Do domestic debtors have ‘rescheduling’ option? High I Rates = Debt Service burdens - Lower loan Performance - Pressure on Banking Systems - Prospects of Financial Collapse - Investor Confidence Fall - Depress Currency Values

NEXT PRESENTATION:

NEXT PRESENTATION What have they done? - the EA5 Is there a correlation? How Important is MP in determining Exchange rates? Tight or Loose? Is there only ‘one kind of MP’ in tackling Exchange rate in crisis? Circumstances?

Monetary policy and its impact on exchange rates after the Asian Financial Crises :

Monetary policy and its impact on exchange rates after the Asian Financial Crises With reference to: “Thailand, Malaysia, Indonesia, Phillippines, Korea” Yunus Mermerci Matt Palumbo Dragos Cazacu

OUTLINE:

OUTLINE What have they done with MP? - the EA5 Korea, Thailand, Philippines,Indonesia, Malaysia Correlation between MP and Foreign Exchange. Importanance of MP in determining Exchange rates. Tight or Loose? Other Influences Is there only ‘one kind of MP’ in tackling Exchange rate in crisis? Circumstances?

What have they done with MP?:

What have they done with MP? At the initial stages: Tight MP for all EA5. Initial hike of interest rates accompanied by depreciations in currencies. Then came accommodating MP with low I rates - Interest Rates dropping below pre-crisis levels - Beneficial to domestic debt problem of firms - Exchange rates broadly stibilizing (except for INR) - Currency Values 15-20% lower than pre-crisis

The EA5- Monetary Policy :

The EA5- Monetary Policy INDONESIA- Macroeconomic stability is fragile with sharp movements in interest rates. Exchange rate market more turbulent. Use of MP and market interventions. 1997 1998 1999 2000 2001 S/T i rates (%) 25.4 41.4 12.2 10.40 16.50 ExC Rate (year end) 2,950 9,900 7,800 8,800 9,950

The EA5- Monetary Policy :

PHILIPPINES- Easing the MP with Lower interest rates, current currency depreciation. Exchange rate defended by MP and some intervention while currency was floated. 1997 1998 1999 2000 2001 S/T i rates (%) 15.8 13.8 10.8 8.8 8.8 ExC Rate (year end) 40.0 39.2 40.3 40.6 51.9 The EA5- Monetary Policy

Slide 24:

The EA5- Monetary Policy THAILAND- BoT held MP accommodating despite fluctuation on oil prices. Short term rates kept low, currency fluctuate as long as against the inflationary targets. Relatively flexible exchange rate. 1997 1998 1999 2000 2001 S/T i rates (%) 10.8 6.0 4.4 4.0 3.8 ExC Rate (year end) 31.4 41.4 37.5 38.5 43.8

Slide 26:

The EA5- Monetary Policy MALAYSIA- CB Interest rate frozen at 5.5 since August 1999. Lending rates has declined more rapidly. Exchange rate fixed to dolar since Sep. 1998. 1997 1998 1999 2000 2001 S/T i rates (%) 9.1 6.5 3.2 3.4 2.8 ExC Rate (year end) 3.9 3.8 3.8 3.8 3.8

Slide 28:

The EA5- Monetary Policy KOREA- Monetary Policy remained largely accomodative. S/T rates maintained at 5.1%. Economic recovery continues. Exchange rate flexible though not a pure float. 1997 1998 1999 2000 2001 S/T i rates (%) 13.2 15.0 5.0 5.1 5.1 ExC Rate (year end) 1,695 1,205 1,139 1,290 1,274

Monetary Policy Shocks:

M onetary Policy Shocks More volatile than its components: money supply, output, and interest rates Overshooting Lag time

Asia-Before Flotation:

Asia-Before Flotation Before- Lack of regulation & supervision  inappropriate risks were taken Low inflation, but greater than the U.S.

Asia-Proposal/During:

Asia-Proposal/During Proposal-improvements in emerging markets infrastructure to become less sens i tive to capital volatility During-not tight enough to defend exchange rates Actually, monetary policy was not the culprit, so it could not be the solution

After Flotation/Problems:

After Flotation/Problems Is it appropriate to tighten policy after flotation? Central banks position of a lender of last resort is limited to its own currency

Importance of MP in determining ER:

Importance of MP in determining ER ER might have impact on: BOP (less/none volatility of ER) on country ability to service its debt ER might be influenced by: credit spread might have influence on ER credit worthiness (through changing in IR) stock market return

Tight or Loose?:

Tight or Loose? Balance difficult to maintain due rapidly changing of the four business cycles MP too tight/loose: might cause deflation/inflation in economy Tendencies to exaggerate when MP is out of control

Is there only one type of MP tackling ER crisis?:

Is there only one type of MP tackling ER crisis? MP should be both locally and globally tailored to specificity of country’s trade partners and geographic position MP should take in account the advantages of new informational systems that can make it more flexible and easy to implement efficient measures MP should take into account as many market variables as possible

Conclusions (14.12.01):

Conclusions (14.12.01) Pros & Cons regarding control of exchange rates through MP: debate remains unresolved!!! Difficult to use historical data or technical analysis to make decisions Very individual approach different from country to country

THANK YOU!:

THANK YOU!

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